What is Bitcoin? Part 1
According to Wikipedia, Bitcoin is a cryptocurrency. It is a decentralized digital currency without a central bank or single administrator that can be sent from user to user on the peer-to-peer bitcoin network without the need for intermediaries.
Let’s break this definition down into its component parts:
Firstly, what is a crypto currency? A crypto currency is a purely digital asset that is designed to work as a medium of exchange. A crypto currency is also based on strong cryptography. Crypto currencies also enable secure financial transactions, control the creation of additional units, and verify the transfer of assets. Let’s break this definition down further. So, we are talking purely digital here. No bank notes, nothing physical, this is simply computers sharing 1 and 0’s with each other over the internet.
A ‘medium of exchange’ is one of the main properties of money, in that money is a widely accepted token which can be exchanged for goods or services. For me, one of the simplest ways to look at this is to think back to gold (we will come to back to gold regularly) in a time before money. If you wanted to buy chickens from your neighbour, you either had to trade him your prize goat or some gold in whatever quantity you both agreed upon. This was known as the barter system and it survived for centuries. Gold was used as a replacement for the barter system because gold is rare, impossible to copy, and relatively easy to verify.
Now, let’s focus on the decentralized element of the definition. Much to some major governments’ despair, and to many drug dealers delight, no central organization controls Bitcoin. The Bitcoin network crowd sources compute power from around the globe and the code base is founded on open source software. To clarify, Open Source software is behind innovations such as the operating system in your Android phone, the cloud, and even in car infotainment systems, so it nothing to be worried about. For more on open source software visit the Linux Foundation’s website.
The second major point when it comes to the decentralized nature of bitcoin is that no one country’s central bank controls this new currency. Let that sink in for a moment. Imagine the USA not controlling the dollar, the UK not having oversight of the Pound, or the European Union having no control of the Euro. We will revisit this topic in a future blog (or maybe 10) as this element of Bitcoin scares governments around the world and is at the heart of why the disruptive fringes of the Bitcoin community see it as a way to overthrow the established world order.
The final part of the definition is the ability to send Bitcoin from user to user on a peer-to-peer network without the need for intermediaries. You can already wire or send money around the world today, so why is Bitcoin new and different? Well, the difference is the lack of ‘intermediaries’, Banks, or internet companies such as Paypal or Venmo. The lack of intermediaries also means no transfer fees to send the money. These fees can be a small percentage charged per transaction for retail consumers in apps like Venmo or are hidden in exchange rates if you transfer money internationally. If you are a bank or financial institution, these money transfers are a cost of business. Think of them as shipping fees for money.
Banks keep records of who has what, I hear you ask. Yes, Banks do keep records of who has what. These ledgers record which individual has what money in their bank account at any given time. These transactions, either in or out, were kept in manual ledgers before computers. Today these ledgers are typically kept on large mainframe computers in complex databases that form the ‘systems of record’ that sit behind whatever web or mobile application that is being used to interact with them. These ‘systems of record’ sit within every Bank and are proprietary and only communicate across networks with a lot of overhead. One such inter-bank network is SWIFT. For more details on how SWIFT works, you can read more here.
Bitcoin is based on a ‘distributed ledger’ technology called Blockchain that is not controlled by any one intermediary or bank. Think of it as a database that is owned not by anyone, but by everyone in the network. Everyone can see the ‘blocks’ on the network, and therefore we have transparency of who has what, without the need for a Bank in the equation. I will come back to Blockchain as a technology and Distributed Ledger Technology in future posts, as it has wider applications beyond crypto currencies and Bitcoin.
Summary – Bitcoin is a relatively new form of digital money that can be passed to anyone with an internet connection or a mobile phone without the need for a bank to keep track of who has how much money. Simple, right? Well, this is true if you think of Bitcoin as a new form of money. If only things were as simple as that. Some people see Bitcoin as a tradeable asset similar to Stock or Share of a company, and we will come to this in the next blog of “What is Bitcoin?”…